Tuesday, May 5, 2009

Bankruptcy Sleuths Find Cash in Trader Receipts for Lap Dancers

(Bloomberg) -- As Sentinel Management Group Inc. neared collapse in August 2007, piling up $950 million in losses, the Northbrook, Illinois-based investment firm wrote clients, saying it was yet another victim of the credit crunch -- an asset manager that grew too fast as it tried to ratchet up gains for customers.

The Securities and Exchange Commission didn’t buy the explanation of the 28-year-old company, which had about $1.4 billion under management, most of it for futures or commodities traders and hedge funds.

After a week-long examination, the SEC filed a civil suit against Sentinel in U.S. District Court in Chicago, accusing the company of, among other things, using client money to secure a $500 million credit line.

“The clients had no way of knowing that their assets had been used by Sentinel to obtain financing for its own purposes,” the SEC complaint says.

The task of unwinding Sentinel’s affairs and recovering money for an estimated 200 customers now falls to 56-year-old Frederick Grede, a former Chicago Board of Trade executive who is among the nation’s more than 1,400 federally appointed bankruptcy trustees.

These trustees -- along with overseers known as receivers -- find themselves in brisk demand these days as they sort through an avalanche of companies felled by the credit crisis and an assortment of alleged crooks and con artists who may have played a role in it.

Avalanche of Cases

On March 12, Bernard Madoff pleaded guilty to 11 counts of fraud as the operator of a $65 billion Ponzi scheme, the largest such fraud in history. With 64,318 companies filing for some form of bankruptcy last year -- a 50 percent increase from 2007 -- the job seldom has been more crucial.

“What receivers do is indispensable,” says Lewis Freeman, a Miami forensic accountant who has served as both a receiver and a trustee in overseeing the recovery and disposition of assets of companies that have collapsed as a result of frauds and the credit crunch.

“If you think of a case such as Madoff, the receiver all of a sudden is the CEO of a $50 billion fraud, responsible for preserving the assets, gathering information and figuring out where all the money went.”

Trustees and receivers bring broad powers to their jobs, sometimes sparking controversy. They can file civil suits on behalf of creditors, including investors, to recover money. Results of their civil investigations may lead to criminal charges by state or federal prosecutors.

Broad Powers

Federal bankruptcy law has evolved as a loosely regulated field, with no uniform application from jurisdiction to jurisdiction and no standard set of qualifications for those like Grede who get assigned to undertake the often complex work of mopping up defunct or troubled firms.

Grede is new to the trustee field. He won appointment by a federal bankruptcy judge in August 2007 after being nominated by a Sentinel creditors committee, whose members knew him from his 30-year career as a commodities executive. He started out in the Chicago Board of Trade’s surveillance department, conducting spot audits of traders.

A lawyer by education, he brings to his new job a digger’s mentality and a detective’s suspicious mind. His work on the Sentinel case is emblematic of what is core to a trustee’s job: to get to the bottom of a company’s collapse in order to recover assets for creditors.

As he delved into Sentinel’s demise, Grede says the case began to look like a parable of the current economic crisis. Grede laid out that case in a lawsuit filed in October 2007 in Chicago’s U.S. bankruptcy court against Sentinel’s chief trader, Charles Mosley, and its controlling shareholders, CEO Eric Bloom and his father, Philip Bloom, the company’s founder.

‘Phony’ Returns

In that suit, he alleges that the company defrauded and misled clients with “phony” returns while assuring those customers their cash was being parked in safe, liquid commercial paper or U.S. Treasuries. Grede says Sentinel was actually making huge bets on unorthodox 30-year instruments that turned out to be another example of financial engineering gone awry -- and hiding those bets with misleading accounting.

Grede says he began to understand Sentinel’s fondness for those instruments as he probed the machinations of Mosley, who had an alleged fondness for boozy lap dances, limousine rides and, according to additional lawsuits filed by Grede against outside brokers, bribes.

“I call it leverage gone wild,” Grede says. Neither Mosley, nor his lawyers, returned phone calls or e-mails seeking comment. The Blooms, in a settlement of Grede’s suit, agreed to return $10.7 million to Sentinel’s estate in exchange for a release of all claims.

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